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Posted: April 07, 2011

The 101 on the 401(k)

Save now, benefit later

Todd Hauer

Starting and managing a 401(k) sounds like an intimidating feat, and with it come a flood of questions. Do you know what a 401(k) is, how it works and what it can do for you down the line? It can be a confusing financial topic, but if you start with the basics, you'll see why it's worth considering.

A 401(k) plan is a type of retirement plan that is typically set up through your employer and sponsored by money taken from your pretax salary. Out of each paycheck, you allocate either a percentage or dollar amount that you'd like to go towards the 401(k). Many companies offer what is called a "match program" where for every dollar you contribute your employer will match something along the lines of .50 cents to the dollar. This means if you put in 1,000 dollars you would actually be contributing $1,500 following your company's match - an extra 500 dollars and you didn't have to do anything!

Even if you can't afford to put a very large portion of your salary towards a 401(k) plan it's important to understand that a little over a long period of time can definitely still make a huge difference when it comes to your retirement.

Typically 401(k) funds are invested to get a higher percentage of return. Options usually include mutual funds, annuities, fixed-income investments and occasionally company stocks. Although investing can be a risk, you can work with a financial advisor to decide what investment plans are smartest for you. Those who attempt at choosing from a large number of investment options without receiving financial guidance often have a hard time identifying which funds have reasonable fees and which could end up hurting assets over a long period of time.

There are numerous benefits to a 401(k) plan; however, for beginners, here are a few major points to keep in mind. First, just through contributing to your 401(k) every year, you lower your taxable salary. Second, with an employer-matching program you add "free money" to your plan that accrues at the same rate as your personal contributions. And lastly, many 401(k) plans are transferable making it easy for you to take your assets on to your next job or roll them over into an IRA after you leave. Many 401(k) plans today offer participants the option of borrowing against their balances, however, taking money out of a 401(k) before the age of 59 ½ can be costly and include additional taxes, so make sure you're aware of the consequences before trying to pull any of the funds out early.

The younger an individual can start a 401(k) the better; this allows more time for the funds to accrue a higher value and for the individual to put more away over a longer period of time- ultimately making retirement an easier transition. What's most important is that everyone is educated on what a 401(k) plan can do and the different options of how to manage it. Although it's sometimes difficult to put away for something that is so far in the future, setting up and learning about a 401(k) plan can be the best and most important financial decision an individual makes.
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Todd Hauer is a Financial Advisor with the Global Wealth Management Division of Morgan Stanley Smith Barney in the Denver Tech Center. He can be reached at 720-488-2406 or toll free at 1-800-347-5099, or you can email him at Todd.Hauer@morganstanleysmithbarney.com.

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Readers Respond

good article. Another good thing about 401k's is that they CAN be used to buy a business. A self directed plan can invest in your OWN corporation if done properly WITHOUT penalty. It allows someone who has developed a 401 while working for someone else to start their own business later in life. It's just another option that your "investment" broker will not tell you about because it might take money away from them. By John Wray on 2011 04 07

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